ONEOK, Inc. (OKE) Earnings Call Transcript & Summary

Welcome for joining us on Day 2 of Citi's Energy, Utilities and Climate Technology Conference. Pleased to have the management team from ONEOK with us today. We have Pierce Norton, Walt Hulse, Kevin Burdick up on stage here. I'm just going to dive right in to questions, if that's all right. Thank you, gentlemen, for joining us. And I guess with that, let's get started.

So I wanted to start with a long-term strategic question for you. One of the things we get from investors, 5 years from now, what do you think ONEOK could look like from a resource-based perspective? Are you going to be migrating out of the Bakken? Or would you be investing more, doubling down? And within that, too, how do the recent North Dakota Pipeline Authority reports on acreage and drilling inventory square with your vision for 5 years from now?

So I'll start with the last question that you asked. North Dakota Pipeline Authority came out with some information recently that showed that there's been some expansion in the number of drilling rigs or actually the number of drill sites that can be accessed at $60 crude, which was, I think, up about 7,000, something like that. And that actually supports the same information that we have based on the geological examinations that we've done. So that also tells you how important that basin is not only to us but to the country. As far as your longer-term question of where we're going to be. One thing for sure is we are definitely going to be in the Bakken. When you use the term migrate away, anything that we would be doing, we look at it as that's one of our core areas. We're definitely committed to that and going to be committed to that for the next 5 years and longer. But anything we would do would be additive, not necessarily migrating away from the basin. So it would be a matter of diversity and getting a more balanced portfolio. As opposed to saying here is exactly where we're going to be, we like to talk about how we get there and why we're going to get there. And it goes back to our vision statement, which is to provide solutions in a transforming energy world. And so we believe that everything that we do today to move the energy products and provide the services that we do is vital to what happens today, and it's going to be vital to what happens 5, 10, 15, 20 years from now. So the other stuff is going to be additive, and we're going to look at that as to what other things can we do with our existing assets that's going to be contributory to a lower carbon world.

Okay. So then maybe segue into sort of a long-term M&A strategy question. What are the types of assets that intrigue you longer term? And is it maintaining the current mix and adding more of the same type or adding more regulated assets? And could you also talk about maybe export infrastructure and assets, particularly given the potential shift to trade flows.

So the assets that are going to be attractive to us are those kind of assets that continue to do what we do today, which is provide those energy services and to move those products. We believe that pipelines and assets today that move these products are probably more valuable than ever. We like to say that pipe in the ground is extremely valuable today. It is more difficult to build new infrastructure facilities in the United States. So those existing facilities are going to become more and more important. So -- and then as far as exporting or whatever, we have said that we've had some interest in a dock. But that's going to be driven by world demand and what kind of contracts that we could also line up to get associated with the dock and the expenses and those kind of things that are associated with that. But it's -- we feel like we're in a really, really good position. Those assets that are going to be attractive to us are especially going to be the ones that can provide that solution to a lower carbon environment. And we have the skill sets -- that's what we do. We build pipelines. We build facilities. We do processing. We do storage. And so we think that lines up really nicely with maybe where the future of energy is going.

Taking on lower carbon then, I wanted to ask a question on emissions reduction. You all have stated a Scope 1 and 2 GHG emissions reduction target of 30% by 2030. Could you help us, where are you along in this journey? How much investment is needed to get there? How much of your CapEx longer term does that represent? Can you walk us through the cadence in deploying the various initiatives to achieve that?

You sound like you're from the SEC. For our -- the new proposal that came out from the Securities and Exchange Commission. But we categorize that into 2 areas, Scope 1 and Scope 2. Scope 1 is what we emit. Scope 2 is the energy that we buy and what kind of carbon footprint that has. But there is more -- when you look at the Scope 2 emissions and the Scope 1 emissions, if you add those together, it gets us more than 30%. So that's the reason that we've chosen this path is because we feel very comfortable that by 2030, we can reduce our emissions by 30%. I'll give you some examples. We may have some older compression that is getting more toward the end of its life, that's gas compression, and stays somewhere in our interstate pipes. We can trade those out to electric compression, and therefore, reduce our emissions of Scope 1. We also are cognizant of the fact that cybersecurity is a big issue in the United States, especially it's been a big issue for years, and it's becoming more and more so an issue with what's going on in Russia and Ukraine. So we also want to look at those kind of engines that not only run on electricity to reduce emissions, but also have the resiliency and the capability that if the power goes down, that they will still run on gas. So there's kind of this built-in redundancy in those. They cost a little bit more, but we think you're getting both in one deal. That's just one example of what we're doing. As far as the total capital that we need to spend between now and the next 8 years, it's really de minimis. And also our plans are to spend that capital but also have an economic return. It's not just spending money just to reduce emissions. So we feel like we've got a really, really good plan. One of the reasons we didn't go out and say we're going to be net subzero by 2050 is because we don't see the technology to get there yet. And so we brought that date back and have a plan. And once the SEC rules and all that stuff gets finalized, we'll lay out every year exactly what it is we're going to do and how much money it is. But it's really -- it's not material as far as the cost of the capital goes, and it will have an economic payback.

Maybe we can switch to a few questions on balance sheet and cash flow. Starting with the cash taxes, eventually, you'll be a cash taxpayer. Could you remind us when that is and is moving away from a DCF coverage and towards the net income payout ratio, is that a way of better aligning the long-term capital allocation and return to shareholder metrics with this shift?

Well, we haven't told anybody when exactly we're going to be a cash taxpayer, so I won't be reminding you of that yet. We had 2 things that really deferred our cash tax liability. The first was when we bought in the partnership and had the step-up basis on our partnership position, that was about a $14 billion write-up. And then we spent $7 billion in capital after that where we got bonus depreciation. So over the course of that period, we built up a meaningful NOL. All of the NOL that was prior to the 2017 Tax Act was completely unrestricted and that covered off 100% of our tax liability. We've pretty much worked through that. And now we're working on the NOL that we created post-tax reform. And there's a limitation there that you can only shelter 80% of your pretax income. So effectively, we'll have the statutory rate of 21% on that 5%. So right around -- I'm sorry, on that 20%, which should give us around a marginal tax rate today in that 4% to 5% range. That's going to run for a number of years going forward. You can actually do the calculation, become pretty close if you kind of go back and look at our NOLs. But we have a meaningful number of years where we still will not be a cash taxpayer. Now we won't become a cash taxpayer on January 1 of 1 particular year. So there will be a year that we are about a mid halfway within the statutory rate, and then we'll get to a full rate down the road. If we don't have significant capital, even bonus continues to scale down, it's still 100% this year, moves down next year, then we'll still enjoy that benefit as we bring assets into service. The move away from DCF coverage really wasn't because of that. That was because as we talked to incremental investors that have not been focused on the midstream space. So they really didn't understand MLP math as we like to call it. They just don't know what DCF coverage is. They're really focused on a dividend payout ratio and what portion of our dividend is being covered by our earnings. So we're really moving to that GAAP measure to open up the pool of investors that we're talking to and give them parameters that they're used to seeing as they evaluate the company.

Understood. And perhaps related to that, as you talk about incremental investors, could you talk about the importance of return on invested capital as a measurement on financial returns to you and specifically to equity? And also within that, how consolidated ROIC has evolved over the years and how that has trended relative to your cost of capital? I'm trying to get a sense of where you think that spread could be between the 2 could settle on a sustainable basis in the longer term.

Okay. Well, thankfully, I don't think it's going to settle. I think it's going to continue to expand for the foreseeable future. We have been one of the outlying companies that return on invested capital has been a measure that we've been compensated on in our short-term incentive plan ever since I joined the company 7 years ago and well before that. So it's been a focus of our management team for quite some time. Obviously, when we went into that $7 billion capital program, we saw a little bit of a move down, so -- just because we were deploying a lot of capital that had not provided a return yet. But even then, I don't think we ever went below where most of our peers are. To give you context, in 2019, our return on invested capital is in the range of 11.5%, give or take. Last year, we were about 13.5%. If you take the midpoint today of our guidance, we'd be over 14% for this year. And with the operating leverage that we have built into our company today because we have capacity on Elk Creek and Arbuckle II that we can utilize by just putting more pumps on to expand the capacity, we've got very significant operating leverage. So we expect that return on invested capital for the next several years to continue to increase as we bring more volume on Elk Creek and really don't have to put any meaningful capital to work to get that incremental EBITDA.

Good. On dividends then, can you talk about the overall goal with how you want to position your dividend yield longer term relative to the broader market? Or are there any specific drivers, shifts you see in the broader market that you think may help you achieve that target?

Well, a lot of people focus on with our dividend, where we are on our debt reduction. We've put out there that we wanted to have a target. We wanted to, in the near term, get to 4x debt-to-EBITDA with an aspirational move towards 3.5x. We are through that 4x today and moving towards the 3.5x. And the reason I bring that up is that people are looking at that as a trigger point to when we will do something with the dividend or buybacks or other capital allocation. And I just want to bring in that we have another parameter that we're looking at and that is that dividend payout ratio. So we're not only looking at just our debt metric, but we're also getting our dividend and earnings in line. I wish I could control what the market did with our yield. We can't. I can say that over time, I think that we will get in a position where dividend increases will be something that we'll have on the table that we will be looking at again. We'll obviously look at share buybacks as well. But part of the reason that we're looking at a payout ratio and positioning our dividend is trying to get into broader pools of funds that are dividend-oriented that look at us. And if you look at our investor material, we've had a funnel that looked at our yield versus the S&P 500. And on a comparative basis, given our earnings growth and the potential for earnings growth, our yield is pretty attractive to those looking at the S&P 500. So we hope to see that yield come down, but naturally come down because of the stock price going up and no other action taken.

Understood. And Walt, you mentioned it but just wanted to ask a bit more, the leverage ratio. So longer term, the goal is to maintain -- is the goal to maintain at 3.5x? I'm not so sure there an advantage to going lower, given everything we talked about on the dividend and the tax payment, cash flow, the whole financial position. Are there any -- do you see the interplay of financial leverage needs with shareholder requirements for returns to equity evolving as one that positions itself relative to those broader indicators?

We're not worried about leverage going below 3.5x. I don't think that we feel that we have to take it below 3.5x, but the agencies are very comfortable at that level. I think that we kind of look at it in a different side of the equation is that we expect there to be another cycle at some point. We can't tell you when it's going to be. They seem to creep up on you very quickly when they come. But when that commodity cycle comes, we won't be just finishing the capital program the next time. And we want to be able -- to be in a position where, no matter what's happening with commodity prices, we're well below 4x on kind of a sustainable basis. So we're giving ourselves some room, and 3.5 is a -- what we've -- we've called it our aspirational goal because we don't want it to be a rock solid point. If we get below it for a while, that's fine. We trend slightly above it, that's fine. But we want to stay in and around that as we manage the company going forward because we think that's an appropriate amount of leverage. But if we had a real spurt in earnings, we aren't going to just -- I don't think we're going to do anything wildly swinging. We're going to just keep a more deliberate approach to capital return.

Okay, makes sense. I'll turn to operations a little bit. G&P volumes and NGL, both -- so at the start of the year has been a bit below the guidance range. And so can you help walk us through the cadence for you within the full year guidance? And what are the drivers for bringing up volumes as we move through the year? What should investors look for signs and guideposts? And similar question on NGLs, how are you trending relative to guide? If you could help us get a little bit of color on that, too.

Sure. We -- as we think about the year, we were tracking exactly where we thought, if not slightly ahead of where we thought we would be as we moved through the first quarter, moved into early April. And that's why on our recent call, we talked about we had reached 1.4 Bcf a day of processed volumes in the Rockies, and we've reached 385,000 barrels a day of NGLs. And so things were tracking nicely. Had the unfortunate event of 2 significant winter storms, blizzard conditions that basically the second one took power down effectively across the entire basin. And that's where, again, on our call, we talked about we were probably 20% off of our volume for the month of April. That's kind of life in the Bakken. Yes, it's a little bit of a hit. Power's back. Those volumes will recover. And the number of rigs, you're sitting right at 40 rigs in the Bakken. You've got a strong number of completion crews up there. And so the volumes are materializing very much like we anticipated. It is highly common that our first quarter volumes are slightly lower than the fourth quarter because of seasonality. Just with the colder weather, more of the gas is burned through the heater treaters on the well site, and therefore, it's just a little bit less gas that comes to us through the gathering system. But everything is extremely positive right now. Our conversations with our customers are all about possibly accelerating completions, accelerating rigs, adding another rig here or there. There's been a lot of producer statements discussing that in their recent calls. So all in all, as we think about the -- especially the back half of the year, at or better than what we were originally thinking. And I think the fact that even with these significant weather events, we came out and reinforced not only just the guidance range but also the midpoints of our guidance, I think, show the strength of where we were prior to the storms.

Helpful. On inflation, one of the big themes at the conference. Are you seeing signs of the current macro inflation environment in your operations? And if so, did inflation become a bit more of a cost headwind ahead to you? Why or why not?

I think there's a couple of dynamics there. Of course, we're seeing a little cost pressure in various areas, rather we're talking about chemicals or material -- other materials or services or things like that. There has been some cost pressure. But on the flip side, if you look at our NGLs business and our gathering and processing business, virtually all those contracts have annual escalators built in that are tied to CPI or PPI or something like that. And we absolutely believe the benefit of those escalations are going to outweigh any cost escalation we may be seeing on the operations side. So net-net, we view that -- we expect that to be a positive this year. And all that kind of data and analysis was embedded in our comments when we reaffirmed our guidance ranges both financially and volumetrically.

One more on operations. Could you help us understand the recent trend in gas/oil ratios? There's been a bit of recent downtrend investors have asked about. Is this temporary due to the operational restarts? And if so, what do you contemplate is the timing for resumption of that longer-term trend?

I think you've got a couple of dynamics going on. I do think there's some seasonal just moving around as far as what volumes are coming from where. We've said before that the GORs across the basin are a little different depending on what areas you're in. So depending on where the volumes come from, that can move that around a little bit. The decrease was only like 0.05 or something like that. So it wasn't significant. If you look back through the history, there are points in times where it will take a little dip only to be followed by strengthening. We're highly confident that number is going to continue to go up. Studies from the North Dakota Pipeline Authority, we've done our own internal studies where there have been consultants that have done studies on the GORs as well as our producers. And all of those believe that, that trend is going to continue to go up. And even in a flat -- just walk through some math on the GORs. Even in a flat crude oil production environment, let's just for easy math, take 1 million barrels a day, which right now it's running about 1.1 million. If it's 1 million barrels a day, even if that GOR goes up 1 turn, so say from 2.6 to 3.6, which if you look at the trend, absolutely is a -- should be a pretty conservative number. That adds another Bcf a day of gas production to the Bakken over the next 4 or 5 years. That Bcf a day turn is effectively 5 processing plants at 200 million cubic feet a day each. Each of those processing plants produces about 25,000 barrels a day of NGLs in ethane rejection. So we're not taking any credit for ethane recovery. Each of those 25,000 barrels a day on our NGL system is about $100 million a year of EBITDA. So that's $500 million a year in EBITDA to our NGL segment, assuming we get those liquids, which we believe is a valid assumption because we are the only out takeaway that has capacity. So that's $500 million, and then you've got the associated gathering and processing. We're roughly half the basin from a market share perspective. If we get half of that Bcf a day, that translates into another $250 million of EBITDA. So in a flat crude oil production environment, at 1 million barrels a day, if the GORs go up 1 turn, that's effectively another $750 million-ish of EBITDA that we would realize over the next 4 to 5 years or as that GOR has increased. So that's the power, A, of the operating leverage we've got, the available capacity we've got in our pipes. With our Demicks Lake III plant, we'll have 1.9 Bcf a day of capacity. We're currently, we said at 1.4, so there's the 500 million a day of capacity that we would need. So with very minimal capital, you might need to add a few pumps, might need to add some compression. But with very minimal capital, we can capture that $750 million.

That's helpful. Last one from me. I think it touches upon a few things both you and Walt said. But can we tie this together -- if we're incorporating your comments on ROIC and cost of capital, is this -- when we're talking about when we talk about current projects in the portfolio, squaring away with the operating leverage, not that you just walked through what Walt talked about, is there more dimensions to that or is that sort of we hitting it on the head with that, that's what ties the 2 together right there?

I think we'll tag team this because I think we all 3 have something to say about this. This is one of my favorite questions because on Page 12 of our investor deck for this conference, you will see the takeaway capacity that we have up in the Bakken on our liquids. You heard some of the math that Kevin just went through. But we had reached a number of 385,000 barrels a day out of the Bakken. We can expand that to 430,000 barrels a day with very, very de minimis capital. The next expansion is going to be a little bit more expensive than that, but it's still immaterial in the amount of money we need to spend to get it to 540,000 barrels a day. So -- and you combine that with Demicks Lake III being completed and MB-5, which has fractionation capacity down in the Gulf Coast. And so for very, very little more money, we've got another -- at least another 200,000, in that range of additional capacity that we can bring on without hardly any capital. That feeds right into more EBITDA, not very much capital being spent. So the ROIC that Walt talked about, going from 11% to 13% to 14% would continue to go up because you're just not spending that much additional capital to actually get all of that outside earnings potential.

Yes. It's pretty obvious when we talk about the Bakken, but at times, I think it's important for us to say that we're not just a one-trick pony. And I'll give you an example of where we've been able to do something similar in the Permian. We bought West Texas LPG back in 2014. And then as our team recontracted that to market rates and we built the associated fracs back in the original capital program I mentioned, we've been looping that line and bringing it from the Permian to where it connects in with our Arbuckle II pipeline. We -- when we built Arbuckle II, we effectively bought an option by upsizing that pipe to a 30-inch so that we can move 1 million barrels a day on Arbuckle II. What that did for us was because we have such a footprint in our business, we were able to get barrels out of the Permian by only going to effectively down. And so we, from a capital standpoint, as we go out and compete for those barrels, we don't have to go the last [ 315.5 miles ] to get down to the coast. So we've got a competitive capital advantage. And we try to do that across -- just used that as an example, one example, but that's been kind of our modus operandi is to see where we have our asset footprint, how can we expand off of that asset footprint such that we'll have a capital advantage against the competition and be able to bring in higher margins. It's kind of a fundamental aspect of how we run the company and how we look at it. The Bakken, we enjoy great opportunities to do it, but we find other places to do it as well.

Thank you. Those are my questions. So I open up to the audience if you have any Q&A. All right. I'm going to yield the remainder of the time and let you get on with your day. Thank you so much for joining us. Thank you all for listening, going to wrap it now. Thanks.

Thank you.

Thanks.

Thank you.